Saturday, June 30, 2012

An empirical observation of real world economies is that the prices of a considerable number of goods respond slowly or incompletely to changes in demand. According to empirical studies in the Western economies, firms only rarely change their prices, perhaps on average once a year (Melmiès 2010: 450).

The genesis of New Keynesian economics was in fact an attempt to establish empirical support for price stickiness, even though the New Classicals argued that the existence of price stickiness allegedly lacked microeconomic foundations in view of their rational expectations theory (Melmiès 2012: 452).

The New Keynesians proposed various explanations of real world price stickiness, including the following factors:

More empirical work established that businesses themselves viewed the implicit contract, nominal contract, coordination failure, and cost-based pricing factors as the most important in affecting price rigidity (Melmiès 2012: 453; Blinder 1998). Most notably, the New Keynesian menu costs, nonprice competition, and costly information ideas did not receive much support (Melmiès 2010: 453).

Furthermore, the New Keynesian idea is fundamentally one of constrained price stickiness: firms wish to change their prices, but are constrained by factors from doing so (Melmiès 2012: 454).

By contrast, Post Keynesians would say that many firms quite deliberately set prices. Firms act to ensure their survival and grow their business and market share. By looking more at the long term state of demand, the price of many products is often not affected by short term changes in demand. The most important cause of price adjustments are changes in the costs of factor inputs and wages. Thus the pricing policies of firms are quite conscious and deliberate acts of price administration and setting, and this action results in a deliberately-caused price stickiness in the market. A consequence of this is that profit margins are also stable, and such margins are needed for internal financing of investment.

It is important to distinguish between the New Keynesian view of price rigidity and that of Post Keynesianism.

New Keynesians believe that, if only prices were perfectly flexible, then economies would adjust rapidly to full employment equilibrium. Post Keynesians, following Keynes himself, reject the view that perfectly flexible wages, prices and perfect competition would lead to full employment equilibrium. Even if there were perfectly flexible wages and prices, there could still be failures of aggregate demand (Davidson 1992).

(3) other supporters of both Ellen Brown and Stephen Zarlenga’s theories.

I am not sure whether Michael Rowbotham and the now largely defunct Social Credit movement might be included in Murphy’s list of “Greenbackers,” but what should be perfectly clear is that his targets are not, as far as I am aware, self-identified supporters of MMT at all.

Let us now see below how virtually the whole article is a waste of time and essentially mangles what MMTers believe.

Take some of Murphy’s major assertions:

“It’s here where the modern Greenbackers go awry. Recognizing the absurdity of allowing bankers to issue new money, then lend it to the government (taxpayers) at interest, the Greenbackers want to cut out the middleman. They want the government to reclaim control of the printing press—which of course need not even “print” money in this age of electronic financial transactions—and to issue new money whenever its spending exceeds its revenue.”

Whatever the “Greenbackers” like Ellen Brown believe is irrelevant to MMT, for such people are not even MMTers at all. In fact, in an MMT system, bonds would still be issued to the private sector, to control interest rates, though there might be some direct purchases by a central bank from the Treasury.

And the system the MMTers propose really isn’t that new: under the ‘tap system’ of issuing government bonds after WWII, a number of Western countries (like Australia) for many years actually had their central banks purchase government bonds directly when such bonds were not all bought by private bondholders. The system is explained by Bill Mitchell of Billyblog:

“[around 1981] the Australian Office of Financial Management was set up as a special part of the Federal Treasury to management federal debt. Previously, bond issues were made using the “tap system”, whereby the government would announce some volume of debt it wanted to issue at a particular rate and then sell whatever was demanded at that yield. Occasionally, given other rates of return in the financial markets the issue would not be fully subscribed – meaning some of the Government’s net spending would be covered in an accounting sense by central bank buying treasury bills (government lending to itself!). The neo-liberals hated this system and regarded it providing no fiscal discipline on government. They knew that by linking deficits $-for-$ with private debt they could more easily mount the debt hysteria and maximize their pressure on government to cut deficits and withdraw from the market.” http://bilbo.economicoutlook.net/blog/?p=3416

Murphy then resorts to scaremongering nonsense:

“The fundamental danger is that an unchecked power to issue new money might prove too tempting for political officials, who would seek to curry favor with the public through various spending programs that were “paid for” through a general rise in prices.”

Again, whatever “Greenbackers” think is not what MMTers think.

Australia had a type of system not far from MMT in its “tap system” of funding deficit spending, and yet contrary to Murphy’s rhetoric the system wasn’t destroyed by evil “political officials” causing some hyperinflationary disaster with their profligate spending: Australia’s inflation rate from 1940 to 1981 was in line with other countries where bonds were always issued to the private sector.

Murphy next moves to ideas that have never been held in MMT:

“In the limit, one could imagine the Greenbacker program not only abolishing government deficits but also all forms of taxation itself. Every year, the government could decide how much it wanted to spend, and then simply “print” that much new money. The IRS could be shut down, and no one would ever need to fill out a tax form again. Besides the savings in explicit tax payments, individuals and businesses would be spared the expense of hiring CPAs. Furthermore, removal of the tax burden would instill a massive dose of “supply-side” incentives for more work and output.

At first blush this sounds like a wonderful proposal.”

Now I have to say I am not familiar enough with the works of Ellen Brown or Stephen Zarlenga to say whether they really think taxes should be completely abolished, but no MMTer, to my knowledge, has ever proposed abolishing taxation, since, as in Keynesianism, MMT sees taxation as a fundamental way to manage aggregate demand. Hence in an MMT system taxes would never be completely abolished. And, as I have said above, bonds would still be issued to the private sector to control interest rates.

Murphy then proceeds from the imagined scenario above to a “debunking” of the “Greenbacker program” by invoking the horrors of hyperinflation and currency collapse.

But it is at this point that Murphy’s article becomes the hogwash that I suspected it would be before reading it: his implied claim to have penned some serious critique of MMT all falls apart when he says:

“To be sure, today there is a sophisticated school of thought—called Modern Monetary Theory or MMT—that is aware of these difficulties. For precisely the reasons I have given, MMTers want to retain the government’s power to tax, in order to “extinguish” money from the system when price inflation is unacceptably high.”

In other words, all Murphy’s objections do not apply to MMT, for MMT never in the first place proposed abolishing taxes or completely “monetizing deficits”*.

Finally, MMT says that, even though deficits are not “financially” constrained, they face real constraints in the inflation rate, exchange rate, available resources, capacity utilization, the unemployment level, and external balance.

In short, Murphy’s article does not need to taken seriously: he does not even engage with anything but a straw man version of MMT.

Note
* I know MMTers object to the phrase “monetising a deficit,” so I will place quotations marks around the phrase.

Monday, June 25, 2012

Rothbard, in the following passage, unintentionally describes the essence of the Austrian business cycle theory:

“What, then, are the causes of periodic depressions? Must we always remain agnostic about the causes of booms and busts? Is it really true that business cycles are rooted deep within the free-market economy, and that therefore some form of government planning is needed if we wish to keep the economy within some kind of stable bounds? Do booms and then busts just simply happen, or does one phase of the cycle flow logically from the other?

The currently fashionable attitude toward the business cycle stems, actually, from Karl Marx. Marx saw that, before the Industrial Revolution in approximately the late 18th century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subject; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions. Since these cycles also appeared on the scene at about the same time as modern industry, Marx concluded that business cycles were an inherent feature of the capitalist market economy. All the various current schools of economic thought, regardless of their other differences and the different causes that they attribute to the cycle, agree on this vital point: that these business cycles originate somewhere deep within the free-market economy. The market economy is to blame. Karl Marx believed that the periodic depressions would get worse and worse, until the masses would be moved to revolt and destroy the system, while the modern economists believe that the government can successfully stabilize depressions and the cycle. But all parties agree that the fault lies deep within the market economy and that if anything can save the day, it must be some form of massive government intervention.” (Rothbard 2009 [1969]: 12–14).

Strangely, it never seems to have occurred to Rothbard that the idea that the cause of business cycle lies within capitalism is actually a view of Hayek:

“we can … see how nonsensical it is to formulate the question of the causation of cyclical fluctuations in terms of ‘guilt,’ and to single out, e.g., the banks as those ‘guilty’ of causing fluctuations in economic development. Nobody has ever asked them to pursue a policy other than that which, as we have seen, gives rise to cyclical fluctuations; and it is not within their power to do away with such fluctuations, seeing that the latter originate not from their policy but from the very nature of the modern organization of credit. So long as we make use of bank credit as a means of furthering economic development we shall have to put up with the resulting trade cycles. They are, in a sense, the price we pay for a speed of development exceeding that which people would voluntarily make possible through their savings, and which therefore has to be extorted from them.” (Hayek 2008: 102).

According to the logic of the ABCT, since capitalism has an endogenous/elastic money supply, not only from fractional reserve banking, but also from things as simple as bills of exchange and promissory notes, it will be hit by perpetual cycles.

It is no surprise that, when Hayek was propounding his business cycle theory at the LSE in the 1930s, his theory was even attractive to socialists, as Skidelsky notes:

“Hayek, like Keynes, hoped to prevent a slump from developing by preventing the credit cycle from starting. But his method was very different. It was to forbid the banks to create credit, something which could be best achieved by adherence to a full gold standard. He was quite pessimistic, though, about this being practical politics, so his conclusion, like Keynes’s, was that a credit-money capitalist system is violently unstable – only with this difference, that nothing could be done about it. One can understand why Hayek’s doctrines attracted a certain kind of socialist: they seemed to reach Marx’s conclusions by a different route. Because of the Austrian school’s close attention to the institutional and political setting of a credit-money economy, Hayek’s picture of the capitalist system in action was altogether more sombre than that of conventional Anglo-Saxon economics, with its story of easy adjustments to ‘shocks.’” (Skidelsky 1992: 457).

In other words, Hayek would have said exactly what Rothbard denied: for Hayek, “business cycles do originate somewhere deep within the free-market economy.”

The Rothbardians attempt to evade what was plainly stated by Hayek by blaming fractional reserve banking (FRB), and arguing that FRB is fraudulent and immoral.

This line of argument shows the most astonishing illogic and ignorance, and I have refuted it before:

The cult of Rothbard stands as one of the most ignorantly anti-capitalist ideologies imaginable, with its gross misunderstanding of, and hostility to, fractional reserve banking – a fundamental institution of capitalism.

BIBLIOGRAPHY

Hayek, F. A. 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard. Ludwig von Mises Institute, Auburn, Ala.

There is some merit in the article, and it is not entirely negative. I have actually enjoyed some of Prychitko’s work in the past (such as Prychitko 1993).

But Prychitko’s own arguments against Minsky have problems as well, some of which I list here:

(1) On p. 218, Prychitko misses the point that effective and careful regulation of the financial markets – the policy actions that stop reckless lending to speculators and that prevent serious asset bubbles before they happen – was already a fundamental Post Keynesian policy prescription long before the 1990s.

Thus Wray’s interpretation of the origins of the 2000s financial crash is in no sense some sudden change in the Post Keynesian explanation of what happened or “post hoc ergo propter hoc reasoning” (Prychitko, p. 218).

Prychitko accuses Wray of misinterpreting “the past decade as a return toward an unhampered market economy.” That is just a straw man: nobody says that the 1980s–2000s saw a creation of some Austrian fantasy world of anarcho-capitalism or Misesian classical liberalism. The point is that the economic system that existed from the 1940s to the late 1970s was modified and attacked by New Classical, monetarist and neoliberal ideologues after about 1980, and was made deeply dysfunctional.

The system was made relatively more laissez faire than what preceded it – not made an “unhampered market economy.”

As for financial deregulation that occurred in these years, the acts that changed the Post-WWII system are easy to list:

Depository Institutions Deregulation and Monetary Control Act (1980)

Garn–St. Germain Depository Institutions Act (1982)
These two acts were major contributors to the Savings and Loan crisis.

Riegle-Neal Interstate Banking and Branching Efficiency Act (1994)

Financial Services Modernization Act of (1999), also called the Gramm-Leach-Bliley Act

Commodity Futures Modernization Act (2000).

The SEC’s Voluntary Regulation Regime for Investment Banks (2004).

(2) It is strange to see Prychitko complain that the FIH is not a general theory of business cycles (p. 220), when even prominent Austrians like Kirzner and Lachmann never thought that the ABCT was a universal theory of cycles either. E.g., here is the opinion of Lachmann:

“The Trade Cycle cannot be appropriately described by means of one theoretical model. We need a number of models each showing what happens when certain potential causes become operative. The many models that have been constructed by economists in the past are therefore not necessarily incompatible with each other. Overinvestment and underconsumption theories, for instance, are not mutually exclusive. None of them of course is the true theory of the Trade Cycle; each is probably an unduly broad generalization of certain historical facts. Once we admit the dissimilarity of different historical fluctuations we can no longer look for an identical explanation. In dealing with industrial and financial fluctuations eclecticism is the proper attitude to take. There is little reason to believe that the causes of the crisis of 1929 were the same as those of the crisis of 1873.” (Lachmann 1978:100–101).

Under the sensible viewpoint of Lachmann that the “many models that have been constructed by economists in the past are therefore not necessarily incompatible with each other,” it would seem that Austrians could accept Irving Fisher’s debt deflation theory of depressions or even Hyman Minsky’s development of that theory in the financial instability hypothesis.

Time preference theory of interest rates is false. Prychitko even uses the imaginary, non-existent natural rate of interest (“To Mises, borrowing from Wicksell, the so-called natural rate of interest has fallen,” p. 213), when even a number of his fellow Austrians (e.g., the later Mises, Hülsmann, and Robert Murphy) are well aware that the Wicksellian unique natural rate does not exist and attempts to found the Austrian business cycle theory on it are flawed:

The US economy already had enormous slack in the early 2000s and the ability to import goods, and there is no reason why credit infusions would cause an unsustainable and serious distortion of the capital structure.

Prychitko also manages to commit the most astonishing distortion of what happened in the 2000s:

“During those years [sc. 2000s], credit-induced demands for new homes caused a doubling of their values—an historically unprecedented event. The housing industry, of course, is a latticework of timely production projects and draws a wide variety of specific (yet complementary) higher-ordered inputs into the housing market.” (p. 215).

But the new housing component of the boom is greatly exaggerated: many of the mortgages in the 2000s were merely refinancing and home equity loans, and the money obtained from the debt not used for new housing construction at all, but to pay credit card debt down or purchase more consumer goods.

In the 2000s the economic effect of the subprime loans (such as liar’s loans or NINJA loans), where people used their houses as ATMs, was an asset bubble in housing, from which exotic CDOs were created.

The economic effects – essentially caused by consumer loans – are clearly very different from the alleged distortions of capital structure imagined in the ABCT. Even if we assume that alleged unsustainable capital structure distortions occurred, they would have been swamped by effects coming from consumer credit expansion to asset bubble speculation, the financial effects of banks loading up on CDOs, MBSs, and CDSs, and then the financial crisis and debt deflation.

(4) Prychitko complains that the FIH “emphasizes uncertainty, but assumes that interventions designed to reduce systemic risk can actually do so.” In response to this, I would say that well-designed government interventions can reduce economic uncertainty:

Monday, June 11, 2012

I will summarise the various Austrian views on the tendency to equilibrium below:

(1) Mises
For Mises, the real world exhibits a tendency to an ideal state of equilibrium, or, as Mises says, the market “at every instant is moving toward a final state of rest”:

“This final state of rest is an imaginary construction, not a description of reality. For the final state of rest will never be attained. New disturbing factors will emerge before it will be realized. What makes it necessary to take recourse to this imaginary construction is the fact that the market at every instant is moving toward a final state of rest. Every later new instant can create new facts altering this final state of rest. But the market is always disquieted by a striving after a definite final state of rest.” (Mises 1998: 246).

(2) Hayek
Hayek’s view on equilibrium evolved over time, and the extent of the changes in his basic ideas has led some scholars to talk about Hayek I and Hayek II as phases in his thought on methodology, and even three phases in his views on equilibrium (Gloria-Palermo 1999: 75). In the first phase down to 1937, Hayek thought that “all legitimate economic explanations should be based upon an analysis of equilibrium” (Gloria-Palermo 1999: 75; McCloughry 1984: viii). The second phase from 1937 to the 1940s involved Hayek’s attempt to redefine equilibrium as plan co-ordination, which occurred in his important paper “Economics and Knowledge” (Hayek 1937; Gloria-Palermo 1999: 75). From the 1940s, there was a third phase where Hayek broke with equilibrium analysis and created a new concept of “spontaneous order” as a method for studying coordination processes in market economies.

Here is Hayek on the concept of general equilibrium from an interview as transcribed in the book Nobel Prize-Winning Economist: Friedrich A. von Hayek (1983, pp. 187–188):

“HIGH: To what extent do you think that general-equilibrium analysis has contributed to the belief that national economic planning is possible?

HAYEK: It certainly has. To what extent is very difficult to say. Of the direct significance of equilibrium analysis to the explanation of the events we observe, I never had any doubt, I thought it was a very useful concept to explain a type of order towards which the process of economics tends without ever reaching it. I’m now trying to formulate some concept of economics as a stream instead of an equilibrating force, as we ought, quite literally, to think in terms of the factors that determine the movement of the flow of water in a very irregular bed.”

From this, is it obvious that Hayek, throughout most of his career, believed in a tendency to equilibrium. Whether, once Hayek replaced general equilibrium with the notion of “spontaneous order,” he still thought that the market has a strong tendency to coordination or “spontaneous order” is unclear.

(3) Rothbard
Rothbard thought that the economy always moves towards an equilibrium state but never reaches it:

“The final equilibrium state is one which the economy is always tending to approach. If our data—values, technology, and resources—remained constant, the economy would move toward the final equilibrium position and remain there. In actual life, however, the data are always changing, and therefore, before arriving at a final equilibrium point, the economy must shift direction, towards some other final equilibrium position. Hence, the final equilibrium position is always changing, and consequently no one such position is ever reached in practice. But even though it is never reached in practice, it has a very real importance. In the first place, it is like the mechanical rabbit being chased by the dog. It is never reached in practice and it is always changing, but it explains the direction in which the dog is moving.” (Rothbard 2009: 320–322).

(4) Gerald P. O’Driscoll and Mario J. Rizzo’s The Economics of Time and Ignorance.
Rizzo and O’Driscoll invoke the concept of pattern co-ordination as an alternative to equilibrium, and see markets as tending to pattern co-ordination (or, that is, some degree of order rather than a strict neoclassical equilibrium state [Prychitko 1993: 374]).

O’Driscoll and Mario J. Rizzo’s The Economics of Time and Ignorance was an attempt to salvage Austrian economics from what they viewed as the nihilism of Lachmann’s radical subjectivist position.

It should be noted how they (O’Driscoll and Rizzo 1996 [1985]: 80-82) see Hayek’s “plan coordination” as just another type of static equilibrium concept.

(5) Ludwig Lachmann and the Radical Subjectivists
Lachmann’s view was that markets do not have an inherent tendency to equilibrium (however defined). It appears that some think that Lachmann’s ultimate views are unclear. Vaughn thinks he regarded markets as subject to both disequilibrating and equilibrating tendencies, but took no position on exactly what tendency dominates the market system (Vaughn 1994: 160; see also Prychitko 1993: 375).

Prychitko holds that there is no a priori basis on which to assert that markets tend to equilibrium states (Prychitko 1993: 375). We have entered a world where expectations may diverge or converge, but even converging expectations are no “guarantee of overall equilibrating tendencies” (Prychitko 1993: 375).

Sunday, June 10, 2012

A follow up on my last post, where I showed that Mises accepted a tendency for market economies to move towards equilibrium (or Mises’s “final state of rest”).

Rothbard thought the same thing, but, curiously, held that it was the evenly rotating economy (ERE) that was the equilibrium state towards which the economy moves but never reaches:

“Analysis of the activities of production in a monetary market economy is a highly complex matter. An explanation of these activities, in particular the determination of prices and therefore the return to factors, the allocation of factors, and the formation of capital, can be developed only if we use the mental construction of the evenly rotating economy. This construction is developed as follows: We realize that the real world of action is one of continual change. Individual value scales, technological ideas, and the quantities of means available are always changing. These changes continually impel the economy in various directions. Value scales change, and consumer demand shifts from one good to another. Technological ideas change, and factors are used in different ways. Both types of change have differing effects on prices. Time preferences change, with certain effects on interest and capital formation. The crucial point is this: before the effects of any one change are completely worked out, other changes intervene. What we must consider, however, by the use of reasoning, is what would happen if no changes intervened. In other words, what would occur if value scales, technological ideas, and the given resources remained constant? What would then happen to prices and production and their relations? Given values, technology, and resources, whatever their concrete form, remain constant. In that case, the economy tends toward a state of affairs in which it is evenly rotating, i.e., in which the same activities tend to be repeated in the same pattern over and over again. Rates of production of each good remain constant, all prices remain constant, total population remains constant, etc.

Thus, if values, technology, and resources remain constant, we have two successive states of affairs: (a) the period of transition to an unchanging, evenly rotating economy, and (b) the unchanging round of the evenly rotating economy itself. This latter stage is the state of final equilibrium. It is to be distinguished from the market equilibrium prices that are set each day by the interaction of supply and demand. The final equilibrium state is one which the economy is always tending to approach. If our data—values, technology, and resources—remained constant, the economy would move toward the final equilibrium position and remain there. In actual life, however, the data are always changing, and therefore, before arriving at a final equilibrium point, the economy must shift direction, towards some other final equilibrium position. Hence, the final equilibrium position is always changing, and consequently no one such position is ever reached in practice. But even though it is never reached in practice, it has a very real importance. In the first place, it is like the mechanical rabbit being chased by the dog. It is never reached in practice and it is always changing, but it explains the direction in which the dog is moving.” (Rothbard 2009: 320–322).

I want to follow up on my last post and show that there is some similarity between Walras and Mises’s ideas on the tendency to equilibrium.

The trouble with Mises is that he had three different concepts of equilibrium, as follows:

(1) the “plain state of rest”;(2) the “final state of rest,” and (3) the “evenly rotating economy” (ERE).

Vaughn explains these concepts:

“[sc. Mises] posits not one, but three notions of equilibrium that he claims underlie his analysis. The first, the ‘plain state of rest,’ is a temporary state in which all currently desired transactions have been made and, for the moment, no one wants to trade. His example of such a state is the close of the trading day in the stock market ....

The second equilibrium notion Mises employs is the “final state of rest,” the state toward which the market tends if there is no change in the data. This apparently is Mises’ analogue to general equilibrium. Whereas the plan state of rest is a phenomenon that is routinely found in markets, the final state of rest is an “imaginary construction” in that it can never be achieved in reality, although it is a necessary analytic tool for understanding the direction of price changes.

Finally, Mises posits yet a third equilibrium notion, the “evenly rotating economy,” or the “ERE.” This, too, is an imaginary construction of what the market would be like if there were no changes in the data. In this construction, however, people continue to be born, to live and to die, and capital is accumulated at a rate just sufficient to maintain current patterns of consumption and investment. It is a condition in which the same products are consumed and produced over and over again, and all prices equal the prices established in the final state of rest .... Whereas the first two notions have their analogues in contemporary economics, the ERE seems to be unique to Mises.” (Vaughn 1994: 81–82).

It is obvious that it is Mises’s “final state of rest” that is the closest concept he has to neoclassical general equilibrium.

If we turn to Human Action, in a section called “The State of Rest and the Evenly Rotating Economy,” we see that the real world exhibits a tendency to this ideal state of equilibrium, or, as Mises says, the market “at every instant is moving toward a final state of rest”:

“The notion of the plain state of rest is not an imaginary construction but the adequate description of what happens again and again on every market. In this regard it differs radically from the imaginary construction of the final state of rest.

In dealing with the plain state of rest we look only at what is going on right now. We restrict our attention to what has happened momentarily and disregard what will happen later, in the next instant or tomorrow or later. We are dealing only with prices really paid in sales, i.e., with the prices of the immediate past. We do not ask whether or not future prices will equal these prices.

But now we go a step further. We pay attention to factors which are bound to bring about a tendency toward price changes. We try to find out to what goal this tendency must lead before all its driving force is exhausted and a new state of rest emerges. The price corresponding to this future state of rest was called the natural price by older economists; nowadays the term static price is often used. In order to avoid misleading associations it is more expedient to call it the final price and accordingly to speak of the final state of rest. This final state of rest is an imaginary construction, not a description of reality. For the final state of rest will never be attained. New disturbing factors will emerge before it will be realized. What makes it necessary to take recourse to this imaginary construction is the fact that the market at every instant is moving toward a final state of rest. Every later new instant can create new facts altering this final state of rest. But the market is always disquieted by a striving after a definite final state of rest.” (Mises 1998: 246).

This is quite similar to what Walras had to say about the tendency to general equilibrium, although that state is never attained.

Saturday, June 9, 2012

There are obviously differences between what Alfred Marshall meant by equilibrium and what neoclassicals like Walras meant by it, but general equilibrium can be defined as a situation where all markets, including the labour market, clear at the same time. It can also be called a “full employment equilibrium.”

A question that immediately occurs is this: did Walras think general equilibrium is ever attained in the real world?

Apparently not:

“Equilibrium in production, like equilibrium in exchange, is an ideal and not a real state. It never happens in the real world that the selling price of any given product is absolutely equal to the cost of the productive services that enter into that product, or that the effective demand and supply of services or products are absolutely equal. Yet equilibrium is the normal state, in the sense that it is the state towards which things spontaneously tend under a régime of free competition in exchange and in production.” (Walras 1954: 224–225).

“Such is the continuous market, which is perpetually tending towards equilibrium without ever actually attaining it, because the market has no other way of approaching equilibrium except by groping, and, before the goal is reached, it has to renew its efforts and start over again, all the basic data of the problem, e.g. the initial quantities possessed, the utilities of goods and services, the technical coefficients, the excess of income over consumption, the working capital requirements, etc., having changed in the meantime. Viewed in this way, the market is like a lake agitated by the wind, where the water is incessantly seeking its level without ever reaching it. But whereas there are days when the surface of a lake is almost smooth, there never is a day when the effective demand for products and services equals their effective supply and when the selling price of products equals the cost of the productive services used in making them. The diversion of productive services from enterprises that are losing money to profitable enterprises takes place in various ways, the most important being through credit operations, but at best these ways are slow. It can happen and frequently does happen in the real world, that under some circumstances a selling price will remain for long periods of time above the cost of production and continue to rise in spite of increases in output, while under other circumstances, a fall in price, following upon this rise, will suddenly bring the selling price below cost of production and force entrepreneurs to reverse their production policies. For, just as a lake is, at times, stirred to its very depths by a storm, so also the market is sometimes thrown into violent confusion by crises, which are sudden and general disturbances of equilibrium. The more we know of the ideal conditions of equilibrium, the better we shall be able to control or prevent these crises.” (Walras 1954: 380–381).

A point that emerges is this: the differences between those Austrian economists who adhere to the view of a strong tendency to general equilibrium in the real world (even if it is never attained) and neoclassicals are greatly exaggerated, for even Walras himself believed the same thing: the state of general equilibrium is an ideal, not “a real state.”

I think important conceptual distinctions should be made between the following:

(1) the state of general equilibrium (which never exists in the real world);

(2) a strong tendency to general equilibrium in the real world. This means market processes are moving in that direction normally and consistently as a natural condition. These processes are “equilibrating mechanisms,” and it is their combined effective operation that creates a strong tendency to general equilibrium;

(3) The “equilibrating mechanisms” or “coordinating mechanisms” should not simply be identified with the actual tendency to general equilibrium in the real world. The latter is a distinct phenomenon, whose existence Post Keynesians would deny.

The “equilibrating mechanisms” for Austrians and neoclassicals are regarded as things such as an equilibrium rate of interest clearing the loanable funds market, equilibrium prices, Say’s law, the tendency of the rate of profit to become uniform, entrepreneurship seeking profit, speculative arbitrage, significantly and quickly flexible wages and prices, and so on.

It can be seen that some of these alleged “equilibrating mechanisms” do not even exist: the equilibrium rate of interest and Say’s law, for example. Others do not actually happen in the real world, such as rapidly adjusting wages and prices.

Of course, even Post Keynesians would not deny that there do exist certain coordinating mechanisms. But the issue is whether the ones that do exist really work in the way imagined by neoclassicals and Austrians.

The alleged combined effective operation of these “equilibrating mechanisms” is really a myth, and so is the strong tendency to general equilibrium.

The fundamental insight of Keynes was that, even if we had perfectly flexible wages and prices, market economies would still not necessarily converge to full employment equilibrium. Significant unemployment could still exist even with perfectly flexible wages and prices.

The insight of Irving Fisher and Hyman Minsky was that price deflation in an environment of high private debt causes debt deflation.

Post Keynesians argue that there is nothing in market systems that ensure that the economy will converge automatically to full employment equilibrium (Davidson 1993: 436). This does not mean that free market economies are inherently disequilibrating, however (Davidson 1993: 436). For Keynes, the most serious flaws in capitalism were as follows:

“The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.” (Keynes 1936: 372).

No doubt there are more radical criticisms that could be made of capitalism, but it is important to make clear what Keynes thought.

Keynes regarded the “unemployment equilibrium” (which is better called an “unemployment disequilibrium”) as capitalism’s natural state:

“our actual experience … [sc. is] that we oscillate, avoiding the gravest extremes of fluctuation in employment and in prices in both directions, round an intermediate position appreciably below full employment and appreciably above the minimum employment a decline below which would endanger life.” (Keynes 1936: 254).

Keynes’s view was that real-world capitalist systems have a tendency to fluctuate around a state well below full employment: this is a major and serious problem of market economies.

I say no such thing. I do not deny that Mises was different from neoclassical economists on the position of equilibrium. I have always accepted that Mises never thought that the ERE or a state of general equilibrium is ever reached in the real world.

(2) Catalán says:

“The world of equilibrium is a world without change; it is purely imaginative. ‘Lord Keynes’ fails to recognize that the evenly rotating economy, as used by Mises, is merely an explicitly fictitious mental construct meant to derive the origins of certain economic relationships. It is nothing more than an ideal type. In the real world, replete with constant change, this fictitious relationship obviously fails to hold.”

I have never asserted that Mises thinks that the ERE is a real world phenomenon. Catalán has simply made this up. In fact, nearly a year ago I wrote a post on Mises’s concepts of equilibrium, and explicitly recognised that, for Mises, the ERE is a fiction:

(3) What I assert is that Mises believed in a “strong tendency towards general equilibrium as a real phenomenon of the market economy,” although the actual state is never reached.

Belief in a tendency to equilibrium is completely compatible with the view that Mises believed that an actual equilibrium state is never reached. I take it that Catalán can understand the difference between (1) a tendency towards general equilibrium, and (2) actual equilibrium as a real world state.

This is exactly what Ludwig Lachmann was saying here:

“Professor Hayek and Mises both espouse the market process, but do not ignore equilibrium as its final stage. The former, whose early work was clearly under the influence of the general equilibrium model, at one time appeared to regard a strong tendency towards general equilibrium as a real phenomenon of the market economy. Mises, calling the Austrians ‘logical’ and neoclassicals ‘mathematical’ economists, wrote: ‘Both the logical and the mathematical economists assert that human action ultimately aims at the establishment of such a state of equilibrium and would reach it if all further changes in data were to cease’ ... It is this view of the market process as at least potentially terminating in a state of long-run general equilibrium that now appears to require revision.

In a kaleidic society the equilibrating forces, operating slowly, especially where much of the capital equipment is durable and specific, are always overtaken by unexpected change before they have done their work, and the results of their operation disrupted before they can bear fruit. Restless asset markets, redistributing wealth every day by engendering capital gains and losses, are just one instance, though in a market economy an important one, of the forces of change thwarting the equilibrating forces. Equilibrium of the economic system as a whole will thus never be reached. Marshallian markets for individual goods may for a time find their respective equilibria. The economic system never does. What emerges from our reflections is an image of the market as a particular kind of process, a continuous process without beginning or end, propelled by the interaction between the forces of equilibrium and the forces of change. General equilibrium theory only knows interaction between the former.” (Lachmann 1976: 60–61).

“Potentially terminating in a state of long-run general equilibrium” is Lachmann’s way of referring to a tendency towards general equilibrium, not the state of equilibrium itself (or the ERE). Even Lachmann’s “equilibrating forces,” I would argue, should be distinguished from a fundamental and strong tendency of the real world market to general equilibrium, because the “equilibrating forces,” as Lachmann says, are thwarted by change, uncertainty and subjective expectations of economic agents which are liable to shift. If the “equilibrating forces” did in fact work consistently and in a reliable way, there would be a strong tendency to general equilibrium in market economies. But they do not.

Once the distinction between

(1) a tendency towards general equilibrium, and (2) actual equilibrium as a real world state

The answer, in my view is, yes, and the Austrian school had its own serious debates from the 1970s to early 1990s when Lachmann’s ideas on the non-existence of any tendency to general equilibrium (or what he called the kaledic economy) were starting to be taken seriously. We need only think of George A. Selgin’s Praxeology and Understanding (1990) where Lachmann’s kaleidic view is opposed to most other Austrians like Kirzner, etc.:

“Central to the current controversy in Austrian economics is the debate concerning whether or not the market harbors a tendency toward equilibrium. The skeptical position, represented by Lachmann, is that no such tendency exists. It is opposed in particular by Kirzner, who attempts to defend the more traditional, praxeological position.” (Selgin 1990: 37).

A passage in Method, Process, and Austrian Economics: Essays in Honor of Ludwig von Mises is also relevant:

“Commentators in the Austrian literature have emphasized and discussed the contrast between Hayek’s view that the tendency to equilibrium is an empirical matter and Mises’s view that it follows logically from the ‘activities of enterprising men.’” (Kirzner [ed.] 1982: 88).

The passage of Mises referred to here is in Human Action:

“Both the logical and the mathematical economists assert that human action ultimately aims at the establishment of such a state of equilibrium and would reach it if all further changes in data were to cease. But the logical economist knows much more than that. He shows how the activities of enterprising men, the promoters and speculators, eager to profit from discrepancies in the price structure, tend toward [p. 356] eradicating such discrepancies and thereby also toward blotting out the sources of entrepreneurial profit and loss. He shows how this process would finally result in the establishment of the evenly rotating economy. This is the task of economic theory. The mathematical description of various states of equilibrium is mere play. The problem is the analysis of the market process.” (Mises 1998: 352-353).

So I am going to say that Mises did indeed adhere to the view that there is a strong tendency to equilibrium in the real world, even if that state never comes about.

This is exactly what Ludwig Lachmann criticised Mises and Hayek for: the view that there is a tendency towards general equilibrium, while Lachmann himself concluded that the economy is an on-going, open-ended “market process” with subjective knowledge and subjective expectations:

“Professor Hayek and Mises both espouse the market process, but do not ignore equilibrium as its final stage. The former, whose early work was clearly under the influence of the general equilibrium model, at one time appeared to regard a strong tendency towards general equilibrium as a real phenomenon of the market economy. Mises, calling the Austrians ‘logical’ and neoclassicals ‘mathematical’ economists, wrote: ‘Both the logical and the mathematical economists assert that human action ultimately aims at the establishment of such a state of equilibrium and would reach it if all further changes in data were to cease’ … It is this view of the market process as at least potentially terminating in a state of long-run general equilibrium that now appears to require revision.” (Lachmann 1976: 60).

In this, Lachmann was entirely correct, and for that (and other reasons too) he has always struck me as Austrian economist worthy of respect, even if I do not agree with him on other issues. (It is not often I defend Austrians!)

There was a time when certain moderate subjectivist Austrians saw merit in constructive mutual dialogue with Post Keynesians. I am thinking here of Gerald P. O’Driscoll and Mario J. Rizzo’s book The Economics of Time and Ignorance (Oxford, UK, 1st edn., 1985; 2nd edn. 1996), where we read:

“[i]t is evident that there is much more common ground between post-Keynesian subjectivism and Austrian subjectivism …. the possibilities for mutually advantageous interchange seem significant” (O’Driscoll and Rizzo 1985: 9).

Of course, Paul Davidson, one of the leading Post Keynesians, was not especially impressed (Davidson 1989 and 1993). “Mutually advantageous interchange” does not seem to have progressed very far since then.

Thursday, June 7, 2012

Murray Rothbard adopted a natural rights ethics to justify his system of anarcho-capitalism. I have already written a post here showing the logical foundations of his ethical system are incoherent and unconvincing.

John Maynard Keynes once wrote of Hayek’s book Prices and Production:

“The book, as it stands, seems to me to be one of the most frightful muddles I have ever read, with scarcely a sound proposition in it beginning with page 45 … It is an extraordinary example of how, starting with a mistake, a remorseless logician can end up in Bedlam.” (Keynes 1931: 394).

With the requisite changes, one can say that same thing about Rothbard’s ethical theory.

When judged by the standards of most other ethical theories (whose starting propositions and arguments are at least not so obviously false as natural rights), the logic of Rothbard’s theory takes him to conclusions that can only be described as moral insanity.

This can be illustrated in Rothbard’s argument for why parents should actually have the legal right not to feed their children and even kill them by starvation or neglect:

“Suppose now that the baby has been born. Then what? First, we may say that the parents-or rather the mother, who is the only certain and visible parent-as the creators of the baby become its owners. A newborn baby cannot be an existent self-owner in any sense. Therefore, either the mother or some other party or parties may be the baby’s owner, but to assert that a third party can claim his ‘ownership’ over the baby would give that person the right to seize the baby by force from its natural or ‘homesteading’ owner, its mother. The mother, then, is the natural and rightful owner of the baby, and any attempt to seize the baby by force is an invasion of her property right.

But surely the mother or parents may not receive the ownership of the child in absolute fee simple, because that would imply the bizarre state of affairs that a fifty-year old adult would be subject to the absolute and unquestioned jurisdiction of his seventy-year-old parent. So the parental property right must be limited in time. But it also must be limited in kind, for it surely would be grotesque for a libertarian who believes in the right of self-ownership to advocate the right of a parent to murder or torture his or her children. We must therefore state that, even from birth, the parental ownership is not absolute but of a ‘trustee’ or guardianship kind. In short, every baby as soon as it is born and is therefore no longer contained within his
mother’s body possesses the right of self-ownership by virtue of being a separate entity and a potential adult. It must therefore be illegal and a violation of the child’s rights for a parent to aggress against his person by mutilating, torturing, murdering him, etc. On the other hand, the very concept of ‘rights’ is a ‘negative’ one, demarcating the areas of a person’s action that no man may properly interfere with. No man can therefore have a ‘right’ to compel someone to do a positive act, for in that case the compulsion violates the right of person or property of the individual being coerced. Thus, we may say that a man has a right to his property (i.e., a right not to have his property invaded), but we cannot say that anyone has a ‘right’ to a ‘living wage,’ for that would mean that someone would be coerced into providing him with such a wage, and that would violate the property rights of the people being coerced. As a corollary this means that, in the free society, no man may be saddled with the legal obligation to do anything for another, since that would invade the former’s rights; the only legal obligation one man has to another is to respect the other man’s rights.

Applying our theory to parents and children, this means that a parent does not have the right to aggress against his children, but also that the parent should not have a legal obligation to feed, clothe, or educate his children, since such obligations would entail positive acts coerced upon the parent and depriving the parent of his rights. The parent therefore may not murder or mutilate his child, and the law properly outlaws a parent from doing so. But the parent should have the legal right not to feed the child, i.e., to allow it to die. The law, therefore, may not properly compel the parent to feed a child or to keep it alive. (Again, whether or not a parent has a moral rather than a legally enforceable obligation to keep his child alive is a completely separate question.) This rule allows us to solve such vexing questions as: should a parent have the right to allow a deformed baby to die (e.g. by not feeding it)? The answer is of course yes, following a fortiori from the larger right to allow any baby, whether deformed or not, to die. (Though, as we shall see below, in a libertarian society the existence of a free baby market will bring such ‘neglect’ down to a minimum.)” (Rothbard 1998: 99–101).

Even as it stands the argument is blatantly unsound:

(1) Rothbard contradicts himself by asserting that a newborn “cannot be an existent self-owner in any sense,” yet arguing in the very next paragraph that every newborn “is therefore no longer contained within his mother’s body possesses the right of self-ownership by virtue of being a separate entity and a potential adult.” Thus the parents’ “ownership is not absolute.” It beggars belief that Rothbard can accept that no child can be killed by active attack, but at the same time can be killed by passive neglect.

(2) According to Rothbard, even though the parents “own” their children in some limited way, they have the legal right to not feed it, and hence kill it by starvation. Rothbard attempts to justify this by appealing to negative rights:

“the very concept of ‘rights’ is a ‘negative’ one, demarcating the areas of a person’s action that no man may properly interfere with. No man can therefore have a ‘right’ to compel someone to do a positive act, for in that case the compulsion violates the right of person or property of the individual being coerced. Thus, we may say that a man has a right to his property (i.e., a right not to have his property invaded), but we cannot say that anyone has a ‘right’ to a ‘living wage,’ for that would mean that someone would be coerced into providing him with such a wage, and that would violate the property rights of the people being coerced. As a corollary this means that, in the free society, no man may be saddled with the legal obligation to do anything for another, since that would invade the former's rights; the only legal obligation one man has to another is to respect the other man’s rights.”

Yet this argument blatantly contradicts Rothbard’s argument elsewhere that creation of fiduciary media (debt money such as fractional reserve banknotes) and use of this as money is not moral, because others suffer the effects of inflation and loss of purchasing power. Yet private transactions in which parties freely and voluntary create and use debt money must be regarded as moral by Rothbard’s own argument here: whatever effects free transactions using debt money have on others’ through inflation is not an argument for banning debt money, for “no man may be saddled with the legal obligation to do anything for another, since that would invade the former’s rights.” Thus Rothbard’s contention that only negative rights must be respected is not even a consistent position in his own work.

It is quite apparent that the Rothbardian moral world is a grotesque, vile and cruel landscape, affording no protection to the most helpless human beings from irresponsible parents. This is a world where parents who are mentally ill, psychopathic or pathologically cruel can kill their children at will, albeit passively by withdrawal of care.

It also raises other issues: if parents have a legal right to withhold food from a newborn child in Rothbard’s mad world, then what about a crippled adult child? If my 40 year old son is a quadriplegic, lives with me and is dependent on me, with no other person to support him, do I as a parent have the legal right to kill him by withholding food or care? Even when he is capable of clearly saying he does not wish to die? If not, why not?

Logically, it appears Rothbard is equally committed to the legal right of parents to kill mentally or physically disabled adult children as well: and, at that point, Rothbard’s world would allow “private sector” groups of humans who, as in Nazi Germany, practise euthanasia of the disabled, even when the disabled vehemently object to being killed.

For most people this is proof enough of the moral bankruptcy both of Rothbard and his natural rights theory, and it is difficult not to agree. (I also direct readers to a fine article by Gene Callahan called “Liberty versus Libertarianism” [2012] that discusses this passage on pp. 8–9.)

As Keynes said of Hayek, one could also say that this is also a perfect example of how Rothbard, starting with flawed assumptions, himself ends up in utter Bedlam.

UPDATE
I also recommend another post on this blog on Rothbard’s family ethics:

Monday, June 4, 2012

I have assembled below a set of links to various posts on my blog for debunking the theories of Austrian economics.

Please note that not all the posts actually debunk Austrian theories, as some are merely descriptive, and allow the reader to understand what the Austrians believe. Some examine the history of the school. A few posts are even constructive in that Post Keynesians and some Austrians can agree on certain points (such as the posts on Ludwig Lachmann).

One important point I have always stressed is that the Austrian school itself is heterogeneous.

In my view, a useful division of modern Austrians would be as follows:

Some of the first generation Austrians were actually progressive liberals and sympathetic to Fabian socialism. Hayek came to support public works and fiscal policy in a depression. Ludwig Lachmann accepted government intervention for economic stability in depressions, and rejected even the idea that free markets tend to general equilibrium.

(9) Against the Austrian View of Deflation
Some Austrians think deflation is desirable; others do not. Hayek most notably changed his mind and condemned “secondary deflation.” The Austrians hold inconsistent views on deflation.

(26) Debunking Austrian Ethical Theories
There are at least two positions taken by Austrians on ethics: (1) some (like Mises) support a kind of utilitarianism/consequentialism, and (2) others support natural rights (Rothbard) or argumentation ethics (Hoppe).